Multistate businesses may see tax cuts in California, court rules

Employee Matt Lococo, left, helps a customer as they look over a Harley-Davidson Inc. CVO Street Glide model motorcycle at the Dudley Perkins Co. dealership in South San Francisco, California, U.S., on Wednesday, July 25, 2012.

Employee Matt Lococo, left, helps a customer as they look over a...

Some multistate businesses could be in line for a reduction in California taxes after a state court raised constitutional doubts about law that gives in-state conglomerates an additional option in calculating their taxable income.

In a suit by Milwaukee’s Harley-Davidson, a state appeals court in San Diego ruled in May that the law discriminates against interstate businesses and must be struck down unless California tax officials can show that it serves a legitimate purpose that can’t be accomplished by even-handed rules.

The Franchise Tax Board did not appeal. The ruling became final Wednesday when the state Supreme Court denied review of an appeal by Harley-Davidson on another aspect of the decision, which found two of the company’s financial subsidiaries to be taxable in California because of their connections to Harley motorcycle sales outlets in the state.

The case now returns to a Superior Court judge in San Diego to decide whether the state can justify treating multistate businesses less favorably than similar enterprises within California.

The ruling “protects the constitutional rights of taxpayers,” Edwin Antolin, a lawyer for Harley-Davidson, said Friday. “We think that’s a very important thing for California.”

The Franchise Tax Board said it would defend the law before the Superior Court judge.

The case involves “unitary” taxation of businesses that operate separately under common ownership and control.

Such businesses, in calculating their California taxes, must take into account revenue from operations in all states and other countries. The California tax is then based on the percentage of the company’s sales, property and payroll within the state.

Similar businesses entirely within California have a second option, known as separate accounting, which calculates taxable income from individual companies based on their revenue — the method also used to calculate federal income taxes. That was once their only option, but a 1980 state law gave in-state companies the additional choice of combining revenue from all operations in the state for a single tax payment.

Antolin said combined reporting sometimes leads to lower taxes, when some of a company’s affiliates elsewhere have suffered losses. The Franchise Tax Board pointed to those situations in arguing that the 1980 law merely leveled the playing field between in-state and multistate businesses.

Photo: Patrick T. Fallon, Bloomberg

The Harley-Davidson motorcycles logo is displayed on a motorcycle for sale at Bartels' dealership in Marina del Rey, California, U.S., on Wednesday, July 24, 2013.

The Harley-Davidson motorcycles logo is displayed on a motorcycle...

But the Fourth District Court of Appeal, in its May 28 ruling, said the state’s “intent, no matter how noble, cannot justify” a law that discriminates against interstate commerce.

“By giving intrastate businesses the right to choose between two methods while restricting interstate businesses to one, (the law) tipped the playing field — at least superficially — in favor of intrastate businesses,” Justice Patricia Benke said in the 3-0 ruling.

She said the tax board has also argued that multistate unitary businesses could manipulate their taxable income, if allowed to divvy it among individual companies, in ways not available to similar businesses within California. That argument, disputed by Harley-Davidson, should be presented to the lower-court judge to determine whether it justifies differential treatment, Benke said.

Antolin, Harley-Davidson’s lawyer, said affected businesses could seek recalculation of their taxes for the previous four years if the law is struck down.